The IRS and Department of Labor Encourage SRI!

Victory! After seven years of delicate but persistent advocacy to the U.S. Department of Labor, one of the key policy priorities for US SIF: The Forum for Sustainable and Responsible Investment has been accomplished.

In 2008, as President Bush was running for the hills, his Department of Labor issued guidance for pension plan fiduciaries that suggested that they should not consider non-financial factors in the investment selection and management process. The guidance had a chilling effect—mission-oriented fiduciaries managing assets for foundations, universities, and public pensions interpreted the guidance as a serious limitation on their discretion to consider the environmental, social, and governance analyses that are fundamental to an SRI approach.

Thankfully, Secretary of Labor Thomas E. Perez was amenable to our advocacy.

Working in my capacity as a member of the Policy Committee of US SIF, it was very rewarding to be part of a constructive dialogue with government regulators. In late 2015, the Department of Labor rescinded the 2008 guidance; pension plans subject to the Employment Retirement Income Security Act of 1974 (ERISA) can now take social factors into account as long as returns are not compromised. At the Alexander Hamilton U.S. Customs House in the heart of Wall Street, with a representative of Morgan Stanley also speaking, Secretary Perez sent the clear message that SRI is a credible, mainstream strategy. “Today, we return to the sound principles … of 1994,” he stated, “that fiduciaries may take social impact into account as ‘tie-breakers’ when investments are otherwise equal”. In fact, new wording was added to the guidance suggesting that there may be instances when, in fact, fiduciary duty requires that a plan take into account ESG and other factors.

In another surprising development, the IRS has announced that private foundations can use their endowments to make impact investments that make less than market-rate returns. While it has long been established that foundations may lose their favorable tax status if they profit from their grants and other charitable endeavors known as program-related investments, the IRS had never previously ruled whether foundations could profit from impact investments, made with endowment funds, and still retain favorable tax treatment. The IRS guidance made clear that they could.

These developments clearly signify a sea change regarding the definition of fiduciary responsibility. For too long, trustees, regents, and investment committees have promulgated the fiction that SRI strategies inherently lead to lower returns, and so would violate their fiduciary duties. These rulings undermine that argument, and “remove a major barrier to getting involved in impact investing,” said Amit Bouri, CEO of the Global Impact Investing Network, a nonprofit industry advocacy group. “To the extent that more pension funds [and other institutional investors] put funds into impact investing, that builds the overall credibility and legitimacy of this investment strategy,” and will attract more investors to the field.

The early responses to these rulings demonstrate increased interest in exploring SRI strategies. The Council on Foundations had an unprecedented 400-participant webinar on the subject shortly after the issuance. Such interest has long been known to SRI insiders, as in 2011 USSIF conducted a study of public and other defined-contribution retirement plans and found that 74% of the 421 respondents said that “clearer legal or regulatory support for fiduciaries to engage in SRI” was either “very important” or “important” in increasing their offerings of SRI options.

A Commonfund Institute study in 2014 revealed that only 24% of the 142 private foundations they surveyed use SRI strategies. The revised guidance is expected to increase that, particularly as fiduciaries examine the return comparison between SRI and conventional investments. Many fiduciaries still have the impression that there must be a tradeoff between return and impact, despite longstanding research that proves otherwise.

The removal of these major regulatory barriers marks a new chapter for the SRI industry, as more and more institutions will feel comfortable bringing their assets into alignment with their mission.

This article first appeared in the Spring 2016 edition of the Natural Investment News

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Michael Kramer

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